Basel III promises huge shake-up in Cash Management products

The new Basel III rules promise to significantly disrupt some of the flagship services offered by banks to their corporate customers under the heading of International Cash Management. Basel III will impact those services the most where the bank currently offsets credit and debit balances in its own books for the purposes of calculating credit and debit interest, regulatory capital, central bank liquidity reserves and liability for deposit protection costs.

These products go under names like “Balance Netting”, “Notional Pooling” and “Interest Optimisation”, and basically come down to a contract where the customer has numerous accounts at the “Pool Bank” in the names of different operating subsidiaries and divisions.

The negative impact of Basel III Liquidity Coverage Ratio on these products has already had quite a bit of coverage: banks will in future have to provision the gross credit balances with a certain proportion of High-Quality Liquid Assets (such as government bonds) unless the account is used as an operational account by the customer, which is a criterion that accounts held in a central location or in an overlay structure will not meet.

Less attention has been devoted to the introduction of a maximum leverage ratio for banks: the target ratio is 3% at least, and is arrived at by dividing the bank’s “Capital Measure” by its “Exposure Measure”. The “Capital Measure” is basically the bank’s Tier 1 capital, so not including any mezzanine debt, subordinated debt or preference shares. The troublesome one is the “Exposure Measure”.

The “Exposure Measure” is the total quantum of positions the bank has in its books that could result in a loss: on- and off-balance sheet. In particular it attacks these types of Cash Management product because exposures have to be recorded at their nominal value, not their risk-weighted value. An overdraft secured on cash in the same currency might well be assigned a risk-weighted value of 2% or less of its nominal value. For Basel III Leverage it is assigned its full nominal value.

Then exposures that have been netted must be recorded gross.

The leading exponent “Pool Bank” nets out the customer’s funds positions 100% in its own balance sheet because it does not allow any pool to have a net long or net short position: the customer must ensure that, at the end of each business day, the credit balances of one set of subsidiaries exactly match the debit balances of the remainder.

This leading “Pool Bank”, before Basel III Leverage, permits the customer to insert an unlimited amount in credit balances into the pool as long as it takes the same amount out of the pool in debit balances. The bank only had capital of EUR332 million at the end of 2014 so, under Basel III Leverage, it could only allow an amount of 332 million divided by 3% = EUR11 billion to be the total aggregate amount in all pools it runs for all customers. It is understood that the equivalent amount today is a multiple of that figure, more like 80 customers each with EUR400 million on both sides of the coin, or an aggregate amount of EUR32 billion.

The leading exponent “Pool Bank” will be hardest hit because its accounting and capital treatment of the service is the most aggressive going in, but as a class of products these “Balance Netting”, “Notional Pooling” and “Interest Optimisation” ones will need considerable re-engineering in order to continue to deliver value to customers.